Key Takeaways
- Payment in lieu of notice (PILON) is usually taxable under a UK settlement agreement and subject to both income tax and National Insurance deductions.
- If your contract includes a PILON clause, your notice pay must go through PAYE and will not form part of any tax-free settlement agreement payment.
- The tax-free element of a settlement agreement, up to £30,000, only applies to genuine ex gratia payments and not to contractual notice or post-employment notice pay (PENP).
- If your employment contract does not contain a PILON clause, HMRC will still expect notice pay taxed as PENP, so negotiating the structure is vital for tax efficiency.
- Settlement agreements should clearly itemise PILON, ex gratia, and other payments, so our solicitors can check if you are being taxed correctly and help you avoid costly mistakes.
- Our solicitors negotiate with your employer to ensure your settlement agreement is structured for legal compliance and the best possible financial outcome, including proper tax treatment.
- Getting independent legal advice from our SRA regulated solicitors is mandatory under the s.203 Employment Rights Act 1996 and is typically free for employees, as your employer pays our fees.
- Settlement Agreement Lawyers are rated Excellent with over 1,400 five-star reviews of our lawyers on Trustpilot, Google and other platforms, and you can book a same-day remote consultation UK-wide.
Do I pay tax on payment in lieu of notice in a settlement agreement?
If you are wondering “Do I pay tax on payment in lieu of notice in a settlement agreement?”, the answer is usually yes: payment in lieu of notice (PILON) is generally treated as taxable earnings in the UK, with income tax and National Insurance deducted under PAYE. Whether or not there is a PILON clause in your contract, HMRC almost always requires the notice period to be taxed, and only genuine compensation payments may qualify for the £30,000 tax exemption.
Before signing, it’s essential to understand how your notice pay, redundancy pay, and any ex gratia settlement are calculated and taxed, as your signature waives your right to make legal claims and finalises your financial outcome. Receiving independent legal advice from one of our solicitors is not only a legal requirement for your settlement agreement to be valid, but your employer nearly always covers the cost—so our advice is usually free to you.
In this article, you’ll learn what counts as PILON, how much tax you can expect to pay, how the £30,000 exemption works, and what you can negotiate to maximise your settlement’s value. If you need fast, expert help, call our solicitors on 0800 054 1144 or book your settlement agreement advice online.
Do I pay tax on payment in lieu of notice in a settlement agreement?
If you receive payment in lieu of notice (PILON) under a settlement agreement, you will almost always pay tax on it. HMRC requires that both contractual notice pay and “deemed notice pay” (known as PENP) are subject to income tax and National Insurance, whether or not your contract explicitly provides for PILON. The only exception is if the payment meets all the criteria for qualifying redundancy compensation or a genuinely ex gratia payment, and even then, the PILON element itself remains taxable.
The method and reason for PILON—whether it is written into your contract or implied by your employer’s conduct—does not change the tax treatment for settlement agreements after HMRC’s 2018 changes. It remains crucial to understand which elements of your settlement are genuinely tax-free and which are not, as mistakes can trigger unexpected tax bills later on.
A client with a three-month notice period was offered a settlement containing £9,000 labelled as PILON and £25,000 as compensation. The PILON was taxed as salary, but the compensation was gross, with the first £25,000 paid tax-free. Our solicitor ensured the agreement’s wording was robust, so HMRC would not reclassify any part of the payment as additional taxable notice pay.
What is Payment in Lieu of Notice (PILON) Under a Settlement Agreement?
Payment in lieu of notice (PILON) is a sum paid by your employer when your employment ends immediately, without working your contractual notice period. In the UK, PILON compensates you for the pay and benefits you would have received if you had worked your notice. Employers often use PILON to facilitate quick exits—such as in redundancy, mutual agreements, or where there are performance or disciplinary concerns—allowing them to remove you from the workplace straight away.
If you work your notice as normal, you continue to receive your full salary and benefits up to the termination date, maintaining continuity and access to usual entitlements (holiday accrual, pension contributions, bonuses, and in some cases, even health cover). With PILON, your employment ends immediately, so benefits typically cease right away and your pay is wrapped up in a lump sum.
The practical note is that PILON is almost always subject to usual deductions (income tax and NICs), whereas some settlement sums (like certain redundancy or ex gratia payments) can be paid gross. Additionally, leaving instantly may affect your ability to claim some benefits, use up annual leave, or accrue further bonus entitlements.
Before agreeing to leave with PILON, always check your employment contract and the settlement breakdown: sometimes bonus or share schemes have strict cut-off dates determined by your actual termination date, not just payment received. Careful timing or negotiation could unlock valuable additional benefits. If you’re unsure, our settlement agreement advice team can walk you through the implications.
Why Do I Need Independent Legal Advice? (s.203 Employment Rights Act 1996 Explained)
Under section 203 of the Employment Rights Act 1996 (see the legislation), you must receive independent legal advice (ILA) before a settlement agreement can legally waive your employment rights. The law is clear: a settlement agreement is not valid unless a qualified, independent solicitor advises you on its terms and effect. This legal safeguard protects you from signing away your statutory claims (including for redundancy, notice pay, or discrimination) without fully understanding the consequences.
Our solicitor will review your settlement agreement, check that the financial and non-financial terms are fair and reasonable, and confirm with you in plain English exactly what claims you’re giving up. Once you’re satisfied, our solicitor issues an ILA certificate to your employer—at which point the agreement becomes legally binding. The law requires your employer to pay our fees, so our advice is always free to you as the employee.
We also support you in negotiations, helping to improve your terms or clarify ambiguous clauses, and can suggest changes to maximise your legal and financial position.
A client facing redundancy came to us with a settlement offer he assumed was standard. Our review revealed several missing payments and an unrealistic post-termination restriction. After our ILA meeting, he successfully negotiated an extra month’s PILON, a £5,000 uplift, and a revised reference clause. You can book your settlement agreement advice online for a same-day remote appointment, and your employer covers the cost.
Is the Financial Offer in My Settlement Agreement Fair?
Every settlement agreement should set out all payments you are due on termination, typically including: payment in lieu of notice (PILON), outstanding salary, accrued but untaken holiday pay, statutory or enhanced redundancy, and any ex gratia (compensatory) amounts. In some cases, you may be entitled to bonus or commission payments due before your leaving date. The size and structure of your overall offer depend on your contract, the statutory minimums, and the circumstances of your exit.
Your settlement agreement is not a “take it or leave it” offer. You can and often should negotiate, especially if you believe the proposal undervalues your claims or omits entitlements. Factors that can drive negotiation value include the risk of unfair dismissal, evidence of discrimination, whistleblowing, or procedural failures by your employer. Our solicitors are highly experienced in identifying missing payments, quantifying claims, and pushing for increased compensation where the facts justify it.
For a precise figure, you can use our quick settlement agreement calculator, which considers your contractual entitlements. If you suspect discrimination or protected disclosures are involved, review our discrimination advice for further guidance on available remedies.
Never accept the first offer at face value—employers often start with their preferred terms, not necessarily what you’re owed or what a tribunal would award. If you’ve raised a formal grievance or believe discrimination has occurred, our solicitors can help you evidence these issues and negotiate a higher figure.
If you want to make sure your settlement agreement is both fair and optimised to maximise your compensation, call our settlement agreement solicitors on 0800 054 1144 or book your settlement agreement advice online. Our service is completely free for employees, as your employer pays the legal fees.
How Is Payment in Lieu of Notice Taxed in a Settlement Agreement?
Do I pay tax on payment in lieu of notice in a settlement agreement? Almost always—HMRC requires that whether PILON is contractual or applied as part of a settlement agreement, it is subject to both income tax and National Insurance. This is the case even if your contract does not mention PILON; from April 2018, tax law (PENP rules) was changed to tax all payments relating to notice pay, regardless of how they’re described.
Contractual PILON is where your contract allows your employer to pay you in lieu of having you work your notice. Such payments are taxed as normal salary. If there is no contractual right to PILON, but your employment ends immediately and you receive compensation that includes pay for unworked notice, HMRC’s “post-employment notice pay” (PENP) rules say this is also taxable through PAYE.
Here’s a simple breakdown:
| Payment type | Taxed as salary? | Eligible for £30,000 tax-free? |
|---|---|---|
| Contractual PILON | Yes | No |
| PENP (statutory calc) | Yes | No |
| Genuine ex gratia | No | Yes (up to £30,000) |
The step-by-step approach:
- Check your contract for a PILON clause.
- Calculate the notice you are owed.
- Identify which part of your settlement covers notice—this is taxable (PILON or PENP).
- The balance (e.g., redundancy or ex gratia) may qualify for tax-free treatment—see next section.
For authoritative guidance, see GOV.UK’s advice on tax rules for settlement agreements and Acas guidance on settlement agreements.
For an individual review of your settlement tax breakdown, our settlement agreement advice service will ensure all sums are correctly treated—avoiding HMRC challenges later.
Check that the PILON/PENP figure in your agreement matches your full notice entitlement, especially where you’ve had pay rises, variable hours, or salary sacrifice schemes—incorrect calculations are common and could underpay you.
Can Any Part of My Settlement Agreement Be Paid Tax-Free? (£30,000 Rule Explained)
The first £30,000 of qualifying redundancy or ex gratia compensation in a settlement agreement can be paid tax-free, as set out in HMRC guidance. However, this exemption does NOT cover PILON or PENP—those sums are always fully taxed. Only “genuine compensation” for loss of employment, such as redundancy pay and certain discretionary sums, are eligible for this tax-free allowance.
Here’s how it works:
- First, calculate and deduct any taxable notice pay (contractual PILON or PENP).
- Add together statutory redundancy, enhanced redundancy, and any additional compensation for loss of office.
- If these aggregate £30,000 or less, they can be paid gross. Above £30,000, the excess is taxable.
Example calculation:
Let’s say your settlement includes:
- £5,000 statutory redundancy
- £20,000 ex gratia compensation
- £8,000 PILON
PILON must be taxed. The £5,000 + £20,000 = £25,000 can be paid gross (tax-free), as this is under the £30,000 limit. If ex gratia was £30,000, then £5,000 redundancy + £30,000 ex gratia = £35,000; the first £30,000 is tax free, and you pay tax on the extra £5,000.
It is important that the settlement agreement clearly distinguishes between taxable notice pay and tax-free compensation. If amounts are wrongly combined, HMRC may disallow the exemption and demand extra tax from you. For more detail, see our redundancy guide and our information on employer-funded advice.
If the agreement is vague or “rolls up” all payments without itemising PILON and ex gratia sums, ask for a detailed schedule—otherwise, you may end up paying unnecessary tax or facing HMRC queries down the line.
What Key Clauses and Risks Should I Check Before Signing?
Settlement agreements contain more than financial terms: key clauses shape your post-employment rights and obligations. Focus especially on restrictive covenants (such as non-compete, non-solicit, and non-poaching clauses), which can limit where and for whom you can work after leaving. Confidentiality clauses affect what you can say about your work and the settlement. Your reference clause should specify what the employer will (and won’t) provide to future employers—vague or negative references can affect your job prospects.
Pay particular attention to tax indemnity clauses, which require you to reimburse the employer should HMRC decide more tax is due on any payment. These are standard but negotiable. Also look for a clear, itemised breakdown of all payments, so there’s no dispute or confusion over what is taxed, what is gross, and what each sum represents.
A simple checklist:
- Are the payments (salary, holiday, PILON, redundancy, ex gratia) set out separately?
- Are any restrictive covenants proportionate and time-limited?
- Is the reference wording satisfactory—and enforceable?
- Are you asked to warrant anything you can’t confirm (e.g., no grievances outstanding)?
Our solicitors can negotiate to clarify clauses, improve the reference, and, where justified, seek to reduce or qualify indemnities.
A senior executive’s draft settlement included a one-year non-compete and a blanket tax indemnity. We negotiated the restriction down to three months and capped the indemnity, significantly reducing future legal risk. For an expert review, visit our settlement agreement advice pages.
If you want an experienced solicitor to review your agreement, negotiate fairer terms, and provide your legally-required advice—call our settlement agreement solicitors on 0800 054 1144 or book your settlement agreement advice online. Remember, it’s free to you as an employee because the employer pays all legal fees.
What Is the Signing and Completion Process for My Settlement Agreement?
Securing your settlement agreement is a multi-step process. Here’s a typical sequence:
- You receive a draft settlement agreement alongside your proposed termination date and offer.
- Book an appointment with our solicitor (usually possible for same-day or next-day advice, fully remote).
- Our solicitor reviews your agreement, checks for fairness, and advises on your rights and options—discussing each clause, payment, and the tax breakdown with you.
- We send a statutory solicitor ILA certificate to your employer, confirming you have received independent legal advice.
- You and your employer both sign the agreement, making it legally binding.
- Your employer processes payment—typically within 7–14 days. You should receive an itemised payslip for any taxed elements and a separate pay statement for gross payments.
After funds clear, check your payslip(s), final P45, and keep all documents safely. If something looks amiss (e.g., underpaid PILON, missing commission or holiday pay), contact us promptly.
For examples of how our quick, remote advice helps employees secure fair settlements, see client success stories.
Never resign or sign anything until you’ve had our solicitor review your settlement agreement and ensure that all sums, especially PILON and ex gratia amounts, are accurately described—you only have one chance to get the legal protections and tax treatment right.
Why Choose Settlement Agreement Lawyers?
Our service is entirely free to employees—your employer pays the legal fees and our fees are always capped at their contribution, ensuring you never face out-of-pocket costs for our settlement advice. As SRA-regulated solicitors, we hold ourselves to the highest standards of client service, confidentiality, and legal professionalism.
We specialise exclusively in settlement agreements: delivering fast, remote appointments (often same-day), high negotiation expertise, and a categorically employee-focused approach. Over 1,400 clients have left us verified 5-star reviews on Trustpilot and Google—reflecting our excellent results and efficient service.
Where many firms process agreements as a formality, our solicitors are proactive in checking every term, identifying missing or wrongly-taxed payments, and pushing back on unfair restrictions or indemnities. We use advanced knowledge of employment law and current HMRC practices to maximise the compensation and protections for our clients, supported by hundreds of client success stories.
To arrange your fast, free advice, simply book now—your employer’s payment means there’s no cost risk, whatever the outcome.
Frequently Asked Questions About Payment in Lieu of Notice Tax in a Settlement Agreement
Is payment in lieu of notice always taxable in a settlement agreement?
Payment in lieu of notice (PILON) is almost always taxable in a settlement agreement. Whether contractual or not, HMRC rules since 2018 require PILON and post-employment notice pay (PENP) to be taxed as earnings. This means tax and National Insurance at your usual rate are deducted before payout.
What is the difference between contractual PILON and ex gratia payments for tax purposes?
Contractual PILON is payment for your notice period required by your contract, and is fully taxable as salary. Ex gratia (compensation) payments are discretionary and can be paid tax-free, up to £30,000, where they are genuine compensation for loss of employment, not notice or contractual sums.
Can my notice pay be paid tax-free as part of my settlement agreement?
No, notice pay cannot be paid tax-free. Whether described as PILON or calculated as PENP, all notice period-related payments must have tax and National Insurance deducted under PAYE. Only redundancy or ex gratia sums qualify for the £30,000 tax-free exemption.
How do I know if my settlement offer is fair?
A fair offer includes all your contractual entitlements (notice, holiday, bonuses) and any additional compensation for waiving claims. Compare with what a tribunal would likely award, considering your length of service, reasons for exit, and any claims you hold. Our solicitors can benchmark and negotiate for you.
What is PENP and how does it affect my tax liability?
PENP, or post-employment notice pay, is an HMRC formula to tax notice pay not covered by a contractual PILON. It ensures all pay for unworked notice is taxed as income, even if the contract is silent. PENP increases your tax liability if any part of a settlement covers unworked notice.
Could I pay too much tax if my settlement agreement is not structured properly?
Yes, if your agreement does not clearly separate taxable PILON/PENP from ex gratia or redundancy payments, HMRC may tax the entire amount. Itemised breakdowns are essential to preserve the £30,000 tax-free exemption on genuine compensation and avoid overpayment of tax.
Do I have to accept my employer’s tax treatment or can I negotiate?
You can negotiate the wording and structure of your settlement agreement to clarify (and maximise) tax-free elements. However, the law dictates notice pay must be taxed. Our solicitors can help ensure the tax treatment fairly reflects your circumstances and HMRC’s rules.
What should I ask my solicitor before signing my settlement agreement?
Ask: Are all my payments correctly calculated and assigned? Is the PILON taxed appropriately? Are restrictive covenants and indemnities proportionate? Does the reference clause protect me? Have all possible claims (unfair dismissal, discrimination, redundancy) been considered in the offer?
Understanding how payment in lieu of notice (PILON) is taxed in a settlement agreement is critical: HMRC almost always requires PAYE deductions on PILON—even when your contract does not mention it. The right legal advice ensures every element of your settlement agreement is calculated, itemised and taxed correctly, preventing costly mistakes and safeguarding your rights on termination. Our solicitors go beyond the basics, advising you on the fairness of your offer, the proper structure of tax-free compensation, and how best to negotiate for improved terms.
Our service is always free to you as an employee—your employer must pay our fees—so you benefit from prompt, expert advice with no risk. We offer same-day remote appointments with SRA-regulated solicitors specialising exclusively in settlement agreements. Your matter is always handled with legal rigour and a sharp focus on maximising both your financial position and legal protection.
To secure your independent legal advice and a compliant ILA certificate, call Settlement Agreement Lawyers on 0800 054 1144, or book your settlement agreement advice online for a same-day remote appointment.
